SGV & Co.

April 13, 2010 BIR RULING [DA-(TAR-001) 046-10] Sec. 43; BIR Ruling No. 005-06; BIR Ruling No. 001-90; BIR Ruling No. DA-432-06 SGV & Co. 6760 Ayala Avenue Makati City Attention: Atty. Emmanuel C. Alcantara Co-Head, Tax Services Gentlemen : This refers to your letter dated March 10, 2008 stating that your clients, TeaM Energy Corporation (TEC), TeaM Sual Corporation (TSC) and TeaM Philippines Energy Corporation (TPEC), are domestic corporations duly registered with the Securities and Exchange Commission (SEC); that TEC and TSC are engaged principally in the business of power generation services and the subsequent sale thereof to National Power Corporation (NPC) under a Build, Operate, Transfer (BOT) scheme while TPEC is engaged in the business of power supply; that TEC and TSC directly own power generation plants in Pagbilao, Quezon and Sual, Pangasinan, respectively; that pursuant to a Cost Reimbursement Agreement effective January 2001, between the affiliated power plants as parties, TeaM Energy Group currently allocates the following costs and expenses related to common operational, maintenance and general administrative requirements of the parties using the asset-based method: Computer Maintenance Utilities (electricity and water) Office Supplies Couriers and Postage Telecommunications Advertising and Marketing Rental of Office Building/Space (common areas included) Rental of Equipments Company Car Maintenance Janitorial Services Security Services Office Building/Space Maintenance Other operational and maintenance, and general and administrative requirements similar to those enumerated Financial and Accounting Services Tax Consulting Services Legal Services Computer Consulting Services that under the asset-based method, the parties to the Cost Reimbursement Agreement agree to bear the said costs and expenses on the basis of the total assets of each party in relation to the total assets of all the parties, which received, used and/or benefited from the common business requirements; that Article V, Section 5.4.2 of the current Cost Reimbursement Agreement on the manner of determining sharing and reimbursement of costs, provides as follows: "5.4.2. Apportion and charge the costs to be reimbursed by each Corporate Participant on the basis of the ratio of the Total Assets of the Corporate Participant to the Total Assets of all Corporate Participants that used and/or benefited from the business requirement that was provided.'' that TeaM Energy Group currently intends to shift its method of allocation from asset-based method to contracted capacity method; that the Contracted capacity as defined under Article III, Section 3.1 of the proposed Cost Reimbursement Agreement refers to the "actual Megawatt (MW) capability of the Power Stations nominated by the parties to their respective customers pursuant to their respective executive bilateral energy conversion agreements and energy power purchase contracts"; that under the contracted capacity method, the same costs and expenses as enumerated above shall be allocated based on the ratio of the total contracted capacity of each power generating plant to the total contracted capacity of all the power generating plants that benefited from the common costs and expenses; that Article 5, Section 5.4.2 of the proposed Cost Reimbursement Method which is to take effect beginning January 1, 2008, provides for the basis of allocation as follows: "5.4.2. Apportion and charge the costs to be reimbursed by each Corporate Participant on the basis of the ratio of the Contracted Capacity of the Corporate Participant to the Contracted Capacity of all Corporate Participants that used and/or benefited from the business requirement that was provided." and that the costs and expenses allocated among the affiliates likewise, include labor costs of support personnel (technical, management and consulting services) covered by a separate Shared Services Agreement. Based on the foregoing representations, you now request for a ruling that: 1. TEC, TSC and TPEC are authorized to change their accounting method on cost allocation from asset-based method to contracted capacity method which shall be applicable to the Cost Reimbursement Agreement and Shared Services Agreement executed by the parties; and 2. The allocation of costs and expenses among affiliated parties to TeaM Energy Group is not subject to income/withholding tax. In reply thereto, please be informed as follows: 1. Section 43 of the Tax Code of 1997 provides that "Sec. 43. General Rule. The taxable income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping with the books of such taxpayer but if no such method of accounting has been employed or if the method does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner clearly reflects the income." Corollarily, Section 167 of Revenue Regulations No. 2 provides that "It is recognized that no uniform method of accounting can be prescribed for all taxpayers and the law contemplates that each taxpayer shall adopt such forms and systems of accounting as are in his judgment best suited to his purpose. Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. Any approved standard method of accounting which reflects taxpayer's income may be adopted." cAaDCE In stressing the rationale of the above-cited provisions, this Office elucidated the matter in BIR Ruling No. 005-06 dated March 8, 2006, as follows: ''. . . the Tax Code itself prescribes no hard and fast rule that would guide taxpayers in allocating expenses where the business involves distinct activities like that of Wyeth, i.e., the operation of its existing two spray dryers (which is subject to regular taxation) and the proposed third dryer (which is subject to ITH). It is recognized that no uniform method of accounting can be prescribed for all taxpayers, and the law contemplates that each taxpayer shall adopt such forms and systems as are in his judgment best suited to his purpose. (Sec. 167, Revenue Regulations No. 2) Allocation of costs is essentially an accounting issue, and given that the law does not expressly provide rules that will govern situations like that of Wyeth, the method of allocation adopted, should, at best, be one that is reasonable and justifiable, and is consistently used. Hence, a method of accounting which reflects the consistent application of generally accepted principles in a particular trade or business in accordance with accepted practices in that trade or business ordinarily is regarded as accurately reflecting income. (Mertens, Law of Federal Income Taxation, Volume 2, Chapter 12B.01) Moreover, it has been held that the allocation of expenses attributable to exempt and non-exempt income is to be based on all the facts and circumstances. (CCH, Standard Federal Tax Reporter, citing Rev. Reg. 63-27, 1963-1CB57)." Prescinding from the foregoing, it is undisputed that the shift from asset-based method to contracted capacity method in the allocation of costs and expenses among the power plants as affiliated companies is reasonable and justifiable, considering the correlation between the expenses incurred by the power plants and income generated as indicated by contracted capacity. Accordingly, the change in method of accounting as to allocation of costs is allowable as long as the same is relevant, consistently applied and favourable to the demands of the business. 2. Mere reimbursements of actual expenses/costs without any mark-up or profit element do not constitute income payments and are, therefore, not subject to Philippine income taxes. Thus, the allocation of costs and expenses pursuant to the Cost Reimbursement Agreement and Shared Services Agreement being mere reimbursement of the actual costs and expenses incurred for the provision of common operational, maintenance and general administrative requirements among affiliated parties are not subject to income and consequently to withholding tax. This Office had already occasion to rule on the matter, when it said in BIR Ruling No. DA432-06 dated July 18, 2006, as follows: ". . . income, in the broad sense, means all wealth which flows into the taxpayer other than as a mere return of capital. It has been a settled rule that reimbursement of cost is merely a return of capital and does not constitute income, and consequently, is not the proper subject of withholding taxes (BIR Ruling Nos. DA489-05 dated December 6, 2005; DA176-04 dated April 6, 2004; DA438-03 dated December 4, 2003 citing BIR Ruling Nos. DA158-97 dated April 14, 1997, UN262-95 dated July 11, 1995 and 245-95 dated July 5, 1995) . CTcSIA xxx xxx xxx In view thereof, and considering that the amounts to be paid under the Memorandum of Agreement between COL-Branch and COL-Head Office represent mere reimbursement of cost, said payments, therefore, are not subject to the withholding tax nor to the branch profit remittance tax both imposed under Reve nue Regulations N o. 2-98, as amended." WHEREFORE, in view of the foregoing, this Office holds that 1. TEC, TSC and TPEC are authorized to change their accounting method on cost allocation from asset-based method to contracted capacity method which shall be applicable to the Cost Reimbursement Agreement and Shared Services Agreement executed by the parties. 2. The allocation of costs and expenses among affiliated parties of TeaM Energy Group is not subject to income tax and consequently to withholding tax. This ruling is being issued on the basis of the foregoing facts as represented. However, if upon investigation, it will be disclosed that the facts are different, then this ruling shall be considered null and void. Very truly yours, (SGD.) GREGORIO V. CABANTAC Deputy Commissioner Legal & Inspection Group